COVID-19 and the issue on exemption of civil liability for breach of payment obligations under loan agreements

Updated: 11:34’ - 06/04/2020

On February 1, Prime Minister Nguyen Xuan Phuc issued Decision 173 declaring the severe acute respiratory syndrome epidemic caused by novel coronavirus (COVID-19) in Vietnam. The outbreak of COVID-19 in the country, together with its corollary impacts to the economy, has raised questions regarding the exemption of civil liability for breach of contract, especially the breach of payment obligations, in an event of force majeure which specially relates to the outbreak of COVID-19. Under the scope of this article, the authors concentrate on force majeure to excuse civil liability under the laws of Vietnam, and the issues relevant to the implementation of loan agreements in the context of COVID-19.

Truong Nhat Quang and Ngo Thai NinhYKVN Law Firm

Prime Minister Nguyen Xuan Phuc chairs a video conference with local administrations to discuss measures to cope with COVID-19 pandemic on March 27__Photo: Thong Nhat/VNA

Vietnam’s regulations on the event of force majeure

Article 156.1 of the 2015 Civil Code (the Code) provides that: “An event of force majeure is an event which occurs in an objective manner, is unforeseeable and is irremediable notwithstanding the application of all necessary measures within the capacity of the obligor.” Besides the Code, the definition of an event of force majeure is also stipulated in other specialized legal documents. Certain specialized legal documents provide specific examples on force majeure events, including natural events such as disaster, fire, explosion, flood, tsunami, epidemic or earthquake or human-caused events such as riot, rebellion, war, hostility, sabotage, embargo, blockade and any other acts of war or hostility. These provisions are generally in accordance with the Code.

Legal consequences in case of the occurrence of an event of force majeure are stipulated in Article 351.2 of the Code, specifically: “If an obligor fails to perform correctly an obligation due to an event of force majeure, such obligor will not bear civil liability unless otherwise agreed or otherwise provided by the law.”

Factors constituting an event of force majeure

Pursuant to Article 156.1 of the Code, an event will be considered force majeure if it: (i) occurs in an objective manner, (ii) is unforeseeable, and (iii) is irremediable notwithstanding the application of all necessary measures within the capacity of the obligor. In addition, based on the provision on legal consequences in case of an event of force majeure under Article 351.2 of the Code, the consequence of the failure to correctly perform a contractual obligation by the affected party should be taken into account when determining for whether an event is considered force majeure in the specific circumstance. As discussed below, in the context of COVID-19, such consequence is likely the most important factor in determining whether COVID-19 will be considered an event of force majeure.

The event occurs in an objective manner

The Code does not provide criteria to determine whether an event occurs in an objective manner. However, it stands to reason that an event occurs in an objective manner if it does not occur at the will of the parties. In other words, the occurrence of such event is caused by neither the parties nor their subjective mistake. So in order to determine the objective factor, it is important to determine whether the defaulting party makes a subjective mistake or intends to cause the occurrence of an event of force majeure. Broadly speaking, if an event of force majeure occurs as a result of action of a party to a contract, it will be difficult for that party to rely on the consequences to argue that an event of force majeure has occurred.

The occurrence of the event is unforeseeable

Like the determination of whether an event occurs in an objective manner, the Code does not provide criteria to determine whether an event is unforeseeable. Simply interpreting, an event is unforeseeable if the occurrence of such event could not be predicted by the parties. The concerned matter is the reasonable time at which the parties should have foreseen the potential occurrence of an event of force majeure, while the Code is silent on this matter. Generally speaking, undertakings and obligations in a contract are agreed by the parties based on the context, conditions and objective factors at the execution of the contract. Therefore, it stands to reason that an event of force majeure should be an event that the parties could not foresee at the execution of the contract. However, what happens if an event that was unforeseeable at the execution of the contract becomes foreseeable during the implementation of the contract? Is it then considered an event of force majeure? In the opinion of the authors, if an event becomes foreseeable after the contract is executed, it stands to reason that such event should not be considered an event of force majeure to excuse civil liability for a default that may occur in the future.

The criteria to determine the ability of the parties to foresee an objective event that may affect the implementation of a contract are not entirely provided in the Code. Such criteria may be applied at the execution of the contract or during the implementation of the contract. Although it is not entirely clear, it may be more reasonable to apply such criteria to consider whether a reasonable person in a similar circumstance may foresee the occurrence of the event. If a reasonable person may foresee the occurrence of an event, such event should not be considered an event of force majeure.

The occurrence of the event is irremediable notwithstanding the application of all necessary measures within the capacity of the obligor

Further to the conditions requiring that an event of force majeure should occur in an objective manner and the occurrence of an event of force majeure should be unforeseeable, the Code also provides that the occurrence of an event of force majeure should be irremediable notwithstanding the application by the obligor of all necessary measures within the capacity of the obligor to remedy the impact of such event on the implementation of the contract. This condition is in accordance with the principles of goodwill and honesty and aims to ensure the performance of the contract by the parties. Accordingly, the obligor should apply all necessary measures within its capacity to perform contractual undertakings and obligations and should not expect the occurrence of an objective impediment to excuse liability to implement the contract.

The Code does not provide any criteria to determine whether the effort of a party is necessary and within its capacity or whether economic factors should be taken into consideration in determining the application of a remedial measure? It may be reasonable to consider remedial measures that a reasonable person in a similar circumstance may apply. Notwithstanding the foregoing, in the opinion of the authors, in every circumstance, it will be unreasonable to allow a party to merely rely on the economic reason for not taking any remedial measure upon the occurrence of an event of default.

The occurrence of the event results in the consequence of the incorrect performance of a contractual obligation by the affected party

The Code does not explicitly regulate the causal relationship between an event of force majeure and the implementation of the contract. It may be implicitly understood that an event of force majeure is a direct cause for the inability of the affected party to correctly perform its contractual obligations. In the context of such approach, the incorrect performance of a contractual obligation due to an event of force majeure may only be acceptable if such event of force majeure is a direct cause preventing the due performance of such contractual obligation by the obligor. Financial hardship arising from the business downturn or recession which has caused a party to be unable to correctly perform its contractual obligations is an indirect cause and should not be considered a reason for that party’s inability to perform contractual obligations. If events being an indirect cause for the inability of a party to perform contractual obligations are taken into account, an event of force majeure may be broadly interpreted, which could lead to the abusive application by the affected party for the exemption of liability.

Legal consequences of an event of force majeure

As discussed above, Article 351.2 of the Code stipulates: “If an obligor fails to perform correctly an obligation due to an event of force majeure, such obligor will not bear civil liability unless otherwise agreed or otherwise provided by the law.” Other than the compensation for damage, the Code does not clearly provide for liabilities from which the defaulting party is exempted.[1] Meanwhile, the 2005 Commercial Law (the Law) addresses this issue in a broader manner that exempts the defaulting party from almost remedial measures, including the compensation for damage, penalty, temporary cessation of contract implementation, rescission of the contract and unilateral termination of the contact.[2]

Based on regulations of the contract law and market practice, in case of a breach of contract, the non-defaulting party may apply a number of remedial measures in relation to financial and non-financial liabilities. Remedial measures in relation to financial liabilities include: (i) compensation for damage, (ii) penalty, (iii) late-payment interest, (iv) advance payment, (v) request for acceleration of undue payment, (vi) set-off of obligations, and (vii) request for payment of other amounts. Remedial measures in relation to non-financial liabilities include: (i) specific performance, (ii) temporary cessation of contract implementation, (iii) rescission of the contract, and (iv) unilateral termination of the contract. Given the Code and the Law specifically enumerate remedial measures exempted from application in an event of force majeure like the compensation for damage, penalty, temporary cessation of contract implementation, rescission of the contract and unilateral termination of the contract. Given the foregoing, there are clear legal grounds for the exemption of the application of those measures. However, the exemption of the application of other remedial measures which are not specifically permitted under the Code and the Law is even more unclear. In the view of the authors, it stands to reason that when an event of force majeure occurs, theoretically, the parties to the contract will be entitled to agree on the exemption of liability in relation to all remedial measures provided under the contract law. Therefore, if the parties seek to exempt liability over remedial measures other than those specified in the Code and the Law), the parties should specifically agree on such issue under the contract.

COVID-19 and the issue on exemption of civil liability for breach of payment obligations under loan agreements

Whether COVID-19 is an event of force majeure?

It appears that COVID-19 may satisfy three conditions to be considered an event of force majeure pursuant to the provisions of the Code in relation to contracts executed prior to the outbreak of the epidemic as COVID-19 (i) occurs in an objective manner (the occurrence of such event is not caused by the parties or by subjective mistake of the parties), (ii) is unforeseeable (out of the prediction of the parties in case the contract was executed prior to the outbreak of the epidemic), and (iii) is irremediable notwithstanding the application of all necessary measures within the capacity of the obligor (the remedy of the epidemic is beyond the capacity of the parties to the contract). However, the determination of whether COVID-19 results in the incorrect performance of a contractual obligation by the affected party, specifically, payment obligations, should be considered in the specific context of each contract.

In the context of a loan agreement, one of the fundamental obligations of the parties to the contract is the payment obligation. Specifically, the lender is obligated to make disbursement and the borrower is obligated to make payment of the principal amount, interest and other payments. The question is whether COVID-19 may be considered an event of force majeure for the exemption of disbursement obligation for the lender and obligations on payment of the principal amount, interest and other payments. Based on the law, market practice and the specific terms of the loan agreement, it is difficult to consider COVID-19 an event of force majeure in this case when the pandemic is not the direct cause for the inability of the lender to perform its disbursement obligation or for the inability of the borrower to perform its obligations on payment of the principal amount, interest and other payments.

Market practice and agreements under the loan agreement

In practice, loan agreements generally do not include a force majeure clause. In the context of contract law, the matter of whether the loan agreement includes a force majeure clause is not important, the regulations on force majeure event will apply regardless of the existence of the agreement of the parties on force majeure events.

Although a basis for the parties to enter into the contract is generally based on the assumption that the force majeure event will not be applied for the loan agreement unless such event of force majeure is a direct cause for the inability to perform the contract. The obligations of disbursement and payment pursuant to the loan agreement are absolute obligations and may not be exempted due to the financial hardship of any party. Almost force majeure events may result in financial hardship for parties to the loan agreement, however, it is difficult to argue that such force majeure events are the direct cause for the inability of the parties to perform the agreement. Therefore, in the context of the loan agreement, it is difficult to consider COVID-19 an event of force majeure to excuse civil liability for the parties due to the breach of payment obligations. The exclusion of the application of regulations on force majeure event in relation to interest payment obligation (and in general may be applied for payment obligations) of the parties to the commercial contract is a practice recognized under the Principles of International Commercial Contracts (UNIDROIT), especially in the United States of America.[3]

In the opinion of the authors, only events directly causing the parties to be unable to perform payment obligations, such as the inactive banking payment system or the prevention of payment under the loan agreement pursuant to foreign exchange regulations, may be considered events of force majeure in relation to payment obligations under a loan agreement. However, in practice, such events are generally not stipulated as events of force majeure under the loan agreement. The loan agreement generally has specific provisions permitting the lender to suspend the disbursement or to accelerate the loan or, in some circumstances, discharging payment obligations of the borrower. Those provisions are conditions precedent for the disbursement, acceleration of the loan and events of default and allocate the risks between the lender and the borrower upon the occurrence of such events and such events are not considered events of force majeure.

Conclusion

COVID-19 has raised practical issues in relation to the application of force majeure events in the context of commercial contracts, including loan agreements. For the implementation of the loan agreement, given payment obligations are fundamental obligations of the agreement, generally, the parties do not permit the lender or the borrower to rely on an indirect cause like the financial hardship to relieve its obligations to perform under the agreement. COVID-19 may be an indirect cause for the non-performance of the loan agreement due to the financial hardship of the parties but it is difficult to be considered an event of force majeure for the exemption of civil liability for the parties to the agreement.

For safety approach, the parties to a loan agreement may agree to exclude the application of regulations on force majeure event under the contract law to ensure that the risk allocation under the agreement is respected. Even without such an agreement, it is difficult to argue that COVID-19 is an event of force majeure which relieves the parties of liability in the event of failure to perform disbursement or payment obligations under the loan agreement.- (VLLF)

[2] Articles 294.1, 300, 303, 308, 310 and 312 of the 2005 Commercial Law. The 2005 Commercial Law uses the definition of “suspension of contract implementation”, this definition is similar to “unilateral termination of contract” as provided under the 2015 Civil Code.